Category: Our Two Cents

How economic forecasts and scenarios can strengthen financial planning

It’s already mid-December 2017. Your organisation has already started (or maybe even finalised) your plans for 2018. You have targets and budgets and tactics lined up to take you confidently into the year ahead. But, did you remember that 2018 is an election year in Barbados? Did you factor that in to your organisation’s financial plans?

Election years are typically characterised by increased government spending (which is often accompanied by increased consumer spending) and greater economic confidence. All of the campaigning and promise-making usually puts everyone in an optimistic frame of mind. Given the state of fiscal affairs in Barbados and the generally depressed economic confidence levels, however, maybe 2018 will buck this trend and it will be more or less business as usual. Or maybe the pessimists amongst us will win the day and 2018 will be the worst year, from an economic standpoint, that Barbados has ever experienced. Has your organisation considered the impact of any of these scenarios?

It has been my experience that the economic forecasts included in corporate financial planning exercises are only baseline forecasts. What do I mean by ‘baseline’? Baseline forecasts typically assume that the future will continue more or less in the same fashion as the recent past. In the case of Barbados, therefore, the next 3 to 5 years – i.e. the usual planning period for corporate budgets – will be characterised by:

low levels of inflation

a fixed 2:1 exchange rate with the U.S. Dollar

economic growth rates around 1%

unemployment around 10%

debt levels over 100%, and,

fiscal deficits over 5% of GDP.

But what if one or more of these assumptions no longer holds?

What if the deficit worsens? What if the exchange rate is adjusted? What if the economy slips back into a recession? What if the country is forced into a programme with the International Monetary Fund? What if 2018 is not business as usual and it’s not a typical election year? What impact will these scenarios have on your organisational plans?

And did you consider how economic policy may change depending on which party is elected?

Each party has different ideas on how the country should be run and where emphasis should be placed. Therefore, depending on which government wins the elections, your plans may no longer be relevant.

Including economic forecasts and scenarios into corporate financial budgeting exercises can help you plan for various plausible futures. Not only will you feel better prepared, whichever outcome, but you will also have a better understanding of the likelihood of each scenario, which would allow you to adjust your resources accordingly. Antilles Economics offers a comprehensive range of economic advisory services – for example, workshops, customised forecasts/scenarios and internal stakeholder briefings – that can provide forecasts and scenarios. And, there are various government agencies that publish their expectations about the future, as well as IMF reports and advisories from the international rating agencies. Once you’re confident that you can translate that information into meaningful intelligence for your organisation, they are reliable and trusted sources of economic data.

I’m looking forward to 2018. I think it will be a very interesting year from an economic standpoint. But what may be interesting for us economists, may be devastating for profit-making enterprises. Make sure you’re prepared.

I once heard a manager proudly tell a new analyst who joined her team that in their business, you have to get comfortable with not having information and making decisions in an environment of great uncertainty. She was not talking about the future and the uncertainty it brings, she was talking about right now. You see, this company did not have good customer or competitor information and over the years she became comfortable with not knowing. She simply assumed that once sales trends were in line with her assumptions, her assumptions about what was happening in the dark were correct. Concepts like coincidence and business cycles never occurred to her. Furthermore, she became adept at convincing others of the same thing and took great pride in the fact that she was comfortable navigating in the dark. After all, it takes a lot of experience to navigate successfully in the dark.

She is not unique. We all seem to accept that we are feeling around in the dark and advise others to get accustomed to not seeing their fingers in front of them. We have become so comfortable with the dark that the light actually scares us. What if the light reveals that we are not where we thought we were? Or that those who we thought were with us have long gone? So we choose to continue operating in the dark, crossing our fingers that we don’t stumble into anything too unpleasant. We actively decide to NOT even turn on a flashlight. I mean, it won’t show us everything anyway, so why bother? Plus, it’s not like we’re uncomfortable.

But does that make sense? Wouldn’t even a little light be better than none at all? Wouldn’t it be better to be sure about a little about your market than nothing at all? Isn’t the investment in a flashlight worth it?

I’m sure that you have heard entrepreneurs in the Caribbean complain that they have a very difficult time sourcing financing. In fact, a World Bank survey for Barbados found that 41% of small businesses stated that access to finance was a major obstacle for their business, compared to 30% of their counterparts across the world.

Over the years we’ve done a number of studies looking at this problem and I’ve come to believe that no one invests in companies anymore. Does this mean that investors are no longer lending money to businesses? Of course not. Corporate loan growth remains a substantial portion of all loans in the Caribbean. So if investors aren’t lending to businesses, why are corporate loans growing? The answer: investors are lending to people.

Lenders of all types have noted that the main determining factor behind whether a loan application would be approved is their management team. Equity prices have long moved in response to changes in senior management personnel, clearly demonstrating the value that investors place on people.

Yet, small business owners frequently pitch their products and develop business plans that spend very little time demonstrating why their management team is capable of executing the plan. We hire our teams out of convenience, preferring to bring in people who we know rather than taking the time, effort and money to hire the best people for the job. We often don’t develop our own business skills, focusing instead on product development. It is no wonder that investors don’t part with their money, we have not demonstrated that we, not the product, deserve it.

As an economist I’m often faced with many misconceptions about the profession and the scope of work that economists do. Everyone expects all economists to be following GDP, inflation, monetary policy and fiscal policy. We’re supposed to be experts on national debt and trade policies. And, we’re supposed to be very critical of policymakers, unless of course we are the policymakers. Notice that I haven’t mentioned anything to do with the corporate world. It’s as if everyone simply ignores the fact that all economists – and all social scientists for that matter – must study both macroeconomics and microeconomics. Somehow in the Caribbean we’ve reached a point where economists have been pigeonholed into only one subsection of the vast field that is economics.

Do we do that to accountants? I don’t think so. We don’t think twice about the large accounting firms publishing fiscal budget reviews, even though that really is a job for economists. They also offer management consultancy, even though we have thousands of persons that are specifically trained in that area. They even branch into law. There’s nothing wrong with what they’re doing. In fact, I applaud them. As a profession, accountants have realised that they have transferable skills and they are broadening their scope. Good for them.

So why are economists expected to stick to macroeconomics and development policy? Why are our only career opportunities either in some form of macroeconomic or development policy or academia? I believe that there are a number of reasons for the narrow scope of our field.

The independent economies of the Caribbean are young. At our birth in the 1960s we needed macroeconomists more than any other kind. We were now starting central banks and running our own governments and we needed economists versed in these areas. As students, most of the Caribbean economists of note are macroeconomists, so naturally we start to believe that to make it in this profession, you should focus on macroeconomics. Fast forward 50 years and I think we’re still stuck here. The current environment reinforces this focus because the Caribbean economies are struggling and the onus is on macroeconomists to solve the problems. But there are only so many positions in macroeconomics and not all economists are passionate about this area of economics.

Another challenge is that other professions do not understand economics enough to recognise how someone trained in the field could add value to a private company. It’s easy to recognise when you need an accountant or a lawyer. Those fields have rules that only accountants or lawyers can navigate. But most people can read a central bank press release so they believe that they understand the implications for their companies or the country at large. Whether they do or they don’t is irrelevant. It’s their belief that they do that limits the opportunities for economists.

Most social scientists have been exposed to Introduction to Microeconomics/Macroeconomics but outside of social science, we do not expose our students to the formal study of economics. As these non-economists start companies or rise in companies, their lack of exposure and understanding hinders their ability to recognise when they need an economist for strategic purposes. Game theory, war games and competition policy are not introduced in first-year introductory courses. Yet, they play a pivotal role in guiding strategic decisions in corporations. In fact, in large companies all over the world, they anchor strategic decision-making. Economists in these companies may be called Strategy Directors or Division Managers, or they may sit on the legal, marketing or finance teams. What they bring to the table is their unique way of looking at choice.

And what about statistics and business analytics? Is there any other field in Caribbean social science more suited to researching, interpreting and analysing vast volumes of quantitative and qualitative data of any kind than economics? Yet we ask our creative teams to analyse market trends. We ask our accountants to forecast revenue. We ask our lawyers to fight our battles on competition policy. And we ask all of these people to do all this work without the support of someone trained in these areas, and we crucify them when they get it wrong.

I believe it is time to re-educate our people on the value of economics and it is beyond time we already in the field push the boundaries that have enclosed our profession.